Financial secrecy deprives countries, especially developing ones, of key revenue resources by eroding their tax base. India must thus build a robust legal system to lift the veil of secrecy on both onshore and offshore financing.

‘Paper companies’, more commonly known as shell companies, are entities with low or no real economic activity, where the identity of the true owner is hidden in layers of secrecy. Kolkata, the first capital of colonial India and a major trading port, became the most desirable destination for the brewing network of shell companies since the 1980s. In the last five years alone, 16,000 companies were registered in the city, many with dormant operations.

According to a statement by the prime minister’s office earlier this year, only 600,000 companies of the 1.5 million registered companies file their tax returns annually. These paper companies broker unaccounted transactions for businesses looking to convert their ‘black’ money to ‘white’ and vice versa. Shell companies can be identified as, but are not limited to, entities with low paid-in minimum capital, no dividend income, high liquidity (cash, low fixed assets), multiple stockholders (mainly private businesses) and low paid-up capital. For example, if there is a party that needs cash and a party looking to launder their illicit cash, shell companies act as intermediaries for both their needs. In other cases, the entry operator divides the prices of the shares only to resell them at higher prices to the directors or other stakeholders of the company.

In Kolkata’s case, while the ease of doing business is lower than in cities like Delhi or Mumbai, the costs related to hiring a chartered accountant – the main brokering service providers – are considerably lower due to economies of scale.

This has effectively made the city a hub for such activities to persist. Most corporates with economic operations in India work in association with these established arrangements and structures in place. Earlier this month, state agencies uncovered nearly 393 shell companies used to round trip illicit funds disguised as foreign investment back to India from tax havens.

The enablers: experts in hiding the trail

Secrecy jurisdictions or tax havens have long been a solace to tax dodgers, criminals, terrorists and the corrupt alike. Scandals like the Panama Papers, LuxLeaks or the Bahama Leaks are a peak into the world of financial secrecy. Companies existing only on paper operate closely with a nexus of professionals like lawyers, chartered accountants, notaries and bankers to facilitate illicit flows, which may be used to finance illegitimate activities. Away from state and public scrutiny, there is little scope of determining the source of these funds. Mounded in layers, like Russian nesting dolls, usually across multiple jurisdictions, such entities inherently represent the broken global financial system. Countries like the US and UK have multiple onshore pockets (Delaware, the City of London among others) with a huge appetite for secretive financing, money laundering and tax avoidance practices. It is common practice for high net worth individuals to structure investments through offshore channels and have assets and shell companies registered in onshore havens like the City of London. An investigation in 2015 revealed that at least £100 billion worth of property across London since 2008 was bought by anonymous structures based overseas.

Financial secrecy deprives countries, especially developing countries, of key revenue resources by eroding their tax base. According to Global Financial Integrity, a Washington-based think tank, developing countries lose over $1 trillion a year to illicit financial flows. Illicit financial flows (known as black money in India) are the illegal cross-border movement of funds from one country to another. These funds may be generated, transferred and/or utilised from activities like money laundering, tax evasion, corruption or criminal financing. Even legal but morally decadent practices like tax avoidance employed by multi-national companies, contribute towards illicit outflows, which heavily impede the effective functioning of social institutions, particularly in developing countries.

India’s context

In the last few months, especially post demonetisation, investigative agencies have intensified their scrutiny on suspicious businesses and activities. The year 2016 also saw major developments such as the Companies (Amendment) Bill (2016) and the Benami Transactions (Prohibition) Amendment Act (2016). The Companies (Amendment) Bill proposes to amend the definition of ‘significant influence’, which would require companies to disclose a person(s) who exercises control of over 25% of ownership or voting rights to be registered under the registrar of companies, Ministry of Corporate Affairs. The registry will also include ‘key managerial personnel’ i.e. next in line to the directors, designated by the board. The proposed threshold of 25%, however, is susceptible to abuse by companies. A company, for example, could appoint multiple representatives to reduce the ownership stake to 20% or lesser and restructure the company ownership on paper. Thus, this would allow companies to sidestep the legislation from reporting the true beneficial owner(s) at all.

On the other hand, the Benami Transactions (Prohibition) Amendment Act defines a benami transaction as one where assets owned are registered under a fictitious name or the transferred assets have been paid by another person where the true owner of the property is untraceable. India currently lacks regulations mandating legal entities to declare the identities of real owners with the registrar of companies. There are also no laws restricting the number of companies registered under the same address. While the Act focuses on confiscation of assets deemed ‘benami’ it does not bring trusts or foundations under its ambit for greater scrutiny.

Establishing public beneficial ownership

Complicated inner legal arrangements between various parties and intermediaries make it harder to establish the real beneficiary who ‘controls’ or ‘owns’ an entity (i.e. company, association, foundation, trust or co-operative society). The documents released from the Panama Papers revealed these layers of complex ownership structures. For example, the real beneficiary of the entity could easily manipulate the structure of the entity by appointing a legal nominee or register the entity as a subsidiary of another anonymous company based out of a tax haven whose ‘beneficial owner’ is unknown, thus creating an impenetrable web. To reveal the degree of control at each level, it is therefore necessary for governments to adopt a robust and working definition of ‘beneficial owner’. A beneficial owner can be defined as the true ‘human owner’ who directly or indirectly owns or has control over an entity or seeks economic benefits from that entity. The definition of a beneficial owner(s) also extends to ‘related parties’ i.e. all trustees, nominees, appointees, board of directors, settlors, protectors, beneficiaries and any other person involved in any direct or indirect arrangement with the entity.

In a bid to strengthen the anti-money laundering (AML) regulations across borders, the financial action task force, an intergovernmental body that advocates global standards for AML and counter-terrorist financing, argued that companies should disclose information on beneficial ownership to their national tax authorities. There is a global call for action to further this by having publicly accessible registry of company ownership that puts an end to this anonymity. After facing a strong fight from the opposition party to establish corporate transparency, Slovakia finally passed the anti-shell company law in October, making public beneficial ownership a reality. Many countries like Norway, Denmark and the UK were among the earliest countries to adopt public register on beneficial ownership information.

An openly accessible register with information on corporate ownership and legal representatives is essential in combatting tax dodging and money laundering practices. In order to reduce errors in the data, it has been argued that even jurisdictions with limited expert personnel or financial resources are more likely to benefit with an open national registry of beneficial owners over a closed/ restricted one.

International consensus and political will on the behalf of governments is imperative to challenging the current international financial architecture that creates a system working for all. Countries around the world should establish publicly accessible corporate ownership registers in an open data format and enact strong national laws to act on the undocumented and unaccounted flow of money. Given the detrimental effects of financial secrecy, it is essential India builds a robust legal system and moves forward by bringing all legal entities under beneficial ownership standards to lift the veil of secrecy on both onshore and offshore financing.

We are a pioneering global network of organizations working on illicit financial flows. We use our wide reach and expertise to influence global norms and standards for financial transparency, and close loopholes in the global financial system. We seek to curtail illicit financial flows through the promotion of a transparent, accountable and sustainable financial system that works for everyone.